What Venture Capitalists Want: Engineers' Guide to Researching Business Opportunities

Engineers see opportunity in their customers' problems. How can the technologically gifted, but not necessarily business-savvy, engineer judge if a nascent opportunity is fundable and feasible? First, make a business plan.

Many of us in the electronics industry have caught the entrepreneurial bug, despite the legends and cautionary tales of almost-successful startups and abject failures. After all, the allure of a startup holds plenty of challenges for the technologically gifted. It's easy to get caught up in a great idea that seems to have unlimited potential, while overlooking what it takes to build a thriving enterprise.

In any industry, almost all companies get started by individuals who work in that industry and identify a problem that their customers are facing with no immediate solution. These individuals set out to solve the problem based on their technical knowledge and relationships with target customers.

This direct experience circumvents much of the research that would be required to tackle a market unknown to the founding team, saving time and expense. Existing relationships might even be leveraged to get funding from a target customer, or the customer might become the early alpha/beta tester that helps refine and ultimately validates the new product. Add to this the fact that no venture capitalist will fund an entrepreneur new to an industry. The VC's sentiment appears to be "You won't get trained on my dime."

The danger with this approach is that the founders might have a myopic view of the opportunity by believing that the problem may be bigger than it actually is because they have felt its impact directly. The team ends up building an add-on feature that addresses a small market and will quickly be offered as part of the larger package sold by market leaders, effectively killing the revenue opportunity for the new technology.

Living the problem vs. studying the problemThis pragmatic approach to market research is what I call living through the problem. At the other end of the spectrum is the structured and more theoretical approach taught in business schools.

Business schools teach their students a generic approach to Business 101, and entrepreneurship classes have become an essential part of the curriculum of MBA programs. The most popular form is the class that requires students to create a business plan culminating in a pitch to a small group of venture capitalists. The final grade is largely decided by the feedback of these volunteer VCs and is analogous to the process an entrepreneur might follow in a quest for funding.

It is a tough task to assemble a business plan and a VC pitch over the 15-week school semester. I had the opportunity to go through this as a MBA student and, more recently, as a mentor who helped students through this process. I found it to be a great experience for both students and mentors, and it is a process I recommend.

I am going to assume that most readers of this blog are technologists who have gained a deep understanding of the markets they work in and want to improve existing solutions. Why, then, mention MBA entrepreneurship programs, because surely a technologist thinking about launching a startup will not take an 18-month pause to get an MBA? While the deliverable of the entrepreneurship class is a business plan, the real value is drafting the plan, which forces the entrepreneurial team to think about all aspects associated with the creation of the new company.

Thanks for your feedback. I reached the very similar conclusion that you outlined: the lack of VC funding needs to be compensated by other creative funding sources. The strategic partners appear as the most likely target. In my mind, it is the completion of the 'circle of innovation'. Let me explain briefly in the context of EDA. No VC means no new technology, so the customers (semis) are starved for innovation, the smart ones will start investing strategically in companies that provide the new technologies they need to create their products.

The flipside is that semi companies sometimes choose to invest into internal development rather than fund promising start-ups. It is happening right now in some of the major semis. It is the traditional 'make vs buy' turned into make internally vs make externally'.

I think the issue is not availability of fund, issue is understanding semi/ EDA business and creating a sustainable RoI model. Major reasons why a VC does not fund in semi/ EDA start-up

1. High fund requirement: May not be true for EDA or IP strat-up, but true for fabless strat-up

2. Longer return time: Any semi/ EDA company takes at least 2 - 3 years (for fabless it is more) to strat earning decent revenue. VCs whose typical investment horizon is 3 - 5 years this is a long duration

3. Absence of tangible asset: The asset created by semi/ EDA company is intangible in nature, if the company is not able to earn revenue or not able to see enough customer traction the exit value is very small

4. Lack of understanding: Good number of VCs does not understand the high tech market very well and they are reluctant to invest

Let us see how these problems can be addressed

1. Creation of strategic investors: A strategic investor is a person/ company who is not only investing in the start-up, but also is a potential customer/ acquirer of the product. In that scenario, his return from the investment goes beyond the cash he received by selling his equity in the start-up. A start-up in semi/ EDA will always look for such investor. Also the big companies who are hungry for new technology to survive create a dedicated fund for start-ups whose technology is relevant to his line of business

2. Equity in exchange of services/ tools: A start-up needs to drive down the cost and should be ready to give up some equity in exchange of services/ tools he needs. For example an IP company can give some equity to an EDA company to get access to the EDA tool. A fabless company can negotiate with a design services company to get design services in exchange of equity. Off course EDA and design services company should also be prepared for that

Agreed: there are two ways EDA can expand beyond its present mature 'perimeter'. First, get into new markets: software development is an often mentioned candidate; new applications such as wearable devices - as you suggest - might be another opportunity. The other key is revamping the business model: EDA 's market size is 1-2% of the semiconductor industry! Clearly EDA is not extracting value from its technology. Cloud offerings might help; more solutions oriented delivery (srevices?) have worked in some cases.

@Michel: I appreciate your candor and the follow up. EDA market in my opinion has attained a high level of maturity and there are only few new product options (other than IP). I think the EDA industry, in order to keep innovative enterprises thriving, has to offer many more solutions than the current generation legacy ones. This is easier said than done but the evolving trends are clearly visible -to cite a few examples, wearable devices, products made with molded interconnect devices (which can be printed with 3D printers), etc. Some of these newer markets that can be easily addressed by EDA companies are not done so because the product pricing and positioning conflicts with existing models.

MP - Fully agreed about the bleak VC funding environment for semi/EDA. I commented about this in a previous blog, 'Improving the EDA funding environment' (7/23/2013). I believe that for EDA the early stages have to covered by angels and 'sweat equity' from the founding team. The process I propose applies to the angels interaction.

The crowdfunding is very interesting but appears to be catching on when the funder is a potential consumer or has some other affinity with the product. This crowd is limited with semi/EDA and reduces itself mostly to angels who have been involved in the industry - either as producers or consumers.

The article is entirely VC-centric and from what I gather, it does not look too encouraging for new hardware startups. On the contrary, look at what is happening in the wearables market including Quantified Self -an majority of the startups in this area have been crowdfunded. Perhaps the author can comment on the subtle and/or direct differences in how a startup team can pitch to crowdfunding sources?

As you point out, the key to maintaining leadership is to create a culture of innovation. Add to this retention and motivation of the good people.

The VC's were - past tense since there are few left in semi - making a bet on one chip: get it right and you make a lot of money, acquisition or IPO ensues and the VC's gets out. So the VC's were making a bet there would be a large market for the chip 2-3 years (the IC design cycle) ahead. Tough call for a concept that is really innovative and requires at least a $20M investment.

Semi business model is inherently scalable, the main caveat to this would be if a heavy dose of services is required for 'design-in' of the new chip.